Real Estate Chronicle

A blog dedicated to real estate matters, finance as well as general economics and political economics issues. Posts written by Luigi Frascati, B.Econ. Your comments and suggestions are appreciated.

Friday, December 29, 2006

Realtors Never Die

The slowdown in the North American housing sector is creating problems for ... Europeans.

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If anyone thought that the present sluggishness in many housing markets in North America was going to hurt Realtors the most is better off to think again. It seems that the slowdown in both the new construction and the resale markets and the consequential drop in pricing levels is having reverberations none other than in ... Europe. This is so because we have reached such a high level of economic integration, that it can be safely stated that when we screw up in North America our European friends end up footing the bill.

Globalization is the term commonly used to refer to the growing economic interdependence of countries worldwide through increasing volume and variety of cross-border transactions in goods and services, free international capital flows, and more rapid and widespread diffusion of technology. Clearly the economic interdependence between the United States and Canada on one side, and many members of the Eurozone - especially those belonging originally to the former Western Europe - on the other side has never been more remarked than now. Not only there is a vigorous flow of capitals going both ways, but also the trade of goods is at its apex. And this appears to be the problem.

The European Union has released economic data as to the end of the third quarter, showing a GDP growth of 3.7 percent annualized, its fastest in six years. So fast, in fact, that for the first time ever the Zone has outrun America, Britain and Japan. The engine that has spurred such record-breaking growth, however, was the ever-increasing consumerism mostly on the part of Americans. In essence, Europe has cashed in on the spending power of Americans, which has increased hand-in-hand with the credit that lenders in North America have extended to consumers, secured by their over-valued and over-appreciated real estate equity.

Consumers in North America have had more financial flexibility these past few years than ever before, and for good or bad they have taken full advantage of it. This flexibility has allowed them to choose to carry debt when in the past they may not have had this option. Additionally, it is certainly true that low interest rates have encouraged more borrowing, which in turn has spurred more spending. All the Porsches, BMWs, Volvos and Mercedes that we see on the streets are proof of it.

Now, however, the tide is changing and the American economic powerhouse is slowing down. This fact alone is causing a series of short-term changes that will make life harder for the Euro economies. North-American consumers seem to be more and more reluctant to snap up German cars, French perfumes and Italian vino. The United States, with an annualized GDP growth of 2.5 percent lead the way, and there is a high degree of scepticism among analysts that European consumers alone will be able to fill the 1.2 percent GDP gap so as to keep the Euro GDP high and steady.

Furthermore all this comes at a time when some Euro area countries, most notably Germany and Italy, are due to tighten their budgets. Their public finances need repairing, and they need to act fast. In Germany, the government wants to raise the value-added tax by three percentage points this coming January. Italy's newly elected government, based on a very frail one percent majority of a coalition of center and leftist parties, is not openly talking about any such drastic moves but, nonetheless, has initiated already a series of public spending cuts which have made the Fall labour market exceeding Italy's sweltering mid-August heat by a few degrees. It would appear that the new economic theory of former Prime Minister Silvio Berlusconi of "lowering taxes and raising pensions" was more palatable to Italians than Romano Prodi's neoclassical approach of "everybody out". Some unions are calling already for a psychiatric evaluation of the new Prime Minister.

Finally, the European Central Bank (ECB) has begun raising interest rates last December and is expected to keep doing so at least until the end of this year. One may wonder why is the ECB poised to increase interest rates at a time when exports are slowing down. The reason lies not with demand but with supply, as unsold inventories are beginning to accumulate, mostly for political reasons. In fact no one dares to lay off workers now, after the civic commotion caused by the recent French rioting.

It turns out, therefore, that real estate agents in North America are not the casualties of the markets taking a breather, at least not the only ones - Europeans stand to lose a lot more.

Tuesday, December 26, 2006

Still No Bubble

Housing prices have declined, but for reasons that have nothing at all to do with bubbles. A quick outlook on 2007.

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Prices of residential real estate, both asking and selling prices, have declined steadily in many markets throughout the country these past few months, but for reasons that have nothing at all to do - not even remotely - with the dreaded real estate bubble so many ‘bubbleologists' were so fond to predict. ‘Bubbleologist', it will be recalled, is the term I have coined specifically to encompass those individuals - all of them of majority age - who specialize in the very fine art of wasting my time.

An economic bubble occurs when speculation causes prices to increase, thus producing more speculation and subsequent price increases. The bubble bursts when prices of goods are so absurdly high that consumers either refuse or cannot afford to purchase, thus sending demand tumbling down. In essence, an economic bubble is a particular market condition, wherein prices of commodities or assets increase to levels so high as to no longer reflect the utility of usage of the commodities or assets being exchanged.

The main cause of an economic bubble is speculation. Speculation is one of the many forces that act on capital at any given time. In theoretical Economics, speculation is defined as ‘the acquisition of financial or capital assets made solely to quickly profit from fluctuations in their prices, or of goods or commodities with no real intent to consume or otherwise use them for production'. Speculation, however, does not seem to be the root cause of the price deflation occurring in many real estate markets.

The main cause of price deflation in the buying and selling of real properties seems to be due to the double effect of 1) a tightening of the money stock which, in turn, alters the cost of borrowing, i.e. a shift in interest rates, and 2) an increase in inventory supplies. Specifically the monetary policy initiated by the Maestro, Alan Greenspan and adopted by the new Fed's Chairman, Prof. Bernanke, is now beginning to have an impact on housing markets in the United States and, to a lesser extent by reflection, in Canada. On August 8, 2006 the Rate-setting Committee of the Federal Reserve System voted to halt the interest rate hike, holding the federal funds rate at 5.25 percent. This signalled a reversal in the trend that has characterized US monetary policy for the past seventeen times in a row.

The Fed admitted that core inflation is high at 2.4 percent annualized for the half-year ending June 30, but the expectation is that it will begin to abate in the latter part of 2006. If it does not, they will start tightening the money stock once again. The Fed has long relied on three factors to keep price pressure in check: quiescent labour markets, fat profit margins and its own credibility. It remains sure of the last, but can no longer count on the first two.

This last meeting reflected the fact that productivity grew at an annual pace of just over 1.1 percent annualized in the second quarter, not nearly enough to offset a recent acceleration in wages. Which means that for all the fuss we hear about oil, labour is the commodity with the biggest impact on inflation, accounting for two-thirds of production costs. Exactly for this reason, therefore, Prof. Bernanke has made a reference and has given a warning at the meeting of August 8 of the dangers of what he terms ‘inflationary psychology'. If people suspect that faster inflation is here to stay, they will anticipate it in their wage claims and price-setting, thus confirming their own suspicions.

This warning is very well heeded, if one considers that according to a survey conducted in July by the University of Michigan, American consumers expect the prices they pay to rise by 3.2 percent over the next twelve months. And this includes, of course, housing.

The slowdown in growth evident in the last quarter and reflected in the real estate sector was not an accident. It is due to the rate increases that the Fed has voted consistently over the last seventeen meetings. The Fed's latest projections, unveiled on August 8, forecast growth of 3.25 - 3.50 percent this year and 3 - 3.25 percent the next, slow enough to stop core inflation from rising much further.

Therefore chances are high the real estate market will continue to be generally stagnant for the next few months, with regional exception. Although no bubble is on the horizon.

Tuesday, December 19, 2006

Are Lady-Realtors Better Than Boy-Realtors?

Sexism at its finest ...

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Let me ask you this: what do you do if Brigitte Bardot decides all of a sudden to show your listing?

Alright, call me sexist (which, may I proudly point out, my doctor says it's in my genes), but this is exactly what has happened to me the other day. I receive a telephone call from this chick ... hem, lady-Realtor saying she wants to show to her clients this apartment I have just listed in Downtown Vancouver. I should have known that the voice was too suave. So this Brigitte Bardot-at-age-28 look-alike shows up with these couple of Buyers, almost accidentally left by me outside the door as I stood there in a state of subliminal, contemplative amazement. And I thought cloning had been vetoed by President Bush - maybe they approved it in Canada.

It will be recalled that one of the many precepts of sexism, that is the attitude based on traditional stereotypes of sexual roles, is whether the things that men are good at are more or less useful than the things women are good at. And by this standard of measure, by my own reckoning, I definitely lost. This is probably so, because modern professional life is dominated by such skills as emotional intelligence, empathy and communication, all of which this lady had absolutely mastered (besides her looks).

Take for example the description she gave to her clients of my listing (a 500-square foot apartment unit on the second floor of a 30-storey high-rise complex), which lasted a good seven minutes (I clocked her). How many things can a man possibly say on a 500-square foot strata unit, before he gets this urge of setting it ablaze. And the view - oh, the view! I swear, while she was describing the view all I could see was the building across the street. I thought the only way one could possibly see any view from here was to bring my Meade telescope and point it to the Milky Way, in hopes of catching a glimpse of the eleventh planet of the Solar System (that's because some scientist has just discovered the tenth planet - I saw it on the Science Channel).

But the culmination of the showing was when this gal began her dissertation on Penstemon grandiflorus. Now, if you think that Penstemon grandiflorus is the skeleton of the newest dinosaur they have just unearthed in the Gobi Desert (I saw it on the Discovery Channel), let me inform you right here and now that you are entirely wrong! Although, one might add, I initially thought of that too, but quickly reached the conclusion that a dino would not fit into a 500-square foot apartment unit. Then, for an unspecified glitch in the wiring of my brain, I figured she was referring to the Giant Squid, the one that this professor from the University of Tokyo has photographed underwater a couple of weeks ago (I saw it on the National Geographic Channel - he now wants to photograph Godzilla). But somehow, that too was not it. Nope. She was talking about this flower contained in a vase next to the window-sill in the living room, most commonly know as ‘large-flowered Beardtongue', as she pointed out to me so as to better render the idea (it did not help, at first). That was exactly the flower I was planning to execute in the next open house - but I digress.

Here is my whole point. Technology and globalization are undermining the usefulness of male skills, and this is all the more evident in real estate, the people's business par excellence. For instance, studies show that men are better than women at rotating three-dimensional objects inside their heads. Which is great, save and except for the fact that nowadays computers and software are better than men's heads at accomplishing the same task. Likewise, men are better than women at building machinery, digging tunnels or slinging bridges across rivers. But then again, now that the world has about as many tunnels and bridges as it needs, not to mention machinery of any size, shape and form, the usefulness of male dominance in these fields is being called into question.

Gentlemen, especially those involved in the fine art of real estate sales, would perhaps be best advised to spend as much time as possible with their female colleagues, boning up on how to undermine somebody's confidence while pretending to boost it, or honing their descriptive skills for the next time they show a 300-square foot cubicle to a client. Such skills are likely to have a greater impact on their overall earnings than the ability to spin an icosahedron inside their heads.

Saturday, December 16, 2006

The Axioms Of Investment Probability

Measuring the chances of successful real estate investing.

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Whether you are an experienced investor or a Buyer who is beginning now to explore the ever-evolving world of real estate, or even if you are merely a cyberspace vagrant who stumbled across this Post by pure coincidence, chances are high that you will agree with my statement that eating chocolate cake every night for dinner does not go a long way towards meeting the generally accepted objective of health and nutrition. If you agree with this statement, however, by implication you also agree on the fact that eating chocolate cake every night for dinner does go some way towards meeting the generally accepted objective of health and nutrition - albeit minimally.

And this is the whole point: some people live to 100 years while smoking, drinking and eating chocolate cake every night throughout their entire lives. Likewise, some lazy people with no education whatsoever get rich, and they do not even have to win the lottery. But those are the exceptions that prove the rule. There are times when one can win by fighting the odds rather than playing with them, but the chances of success are greatly reduced - albeit they still exist. Hence, to maximize returns, there are probabilities that most investors need to put in their favour.

Here is a pleasant surprise. Unlike many of life's other challenges, putting investment odds in one's favour requires very little incremental effort. One doesn't necessarily have to study harder, work harder or eat better. In fact, the less you do, the better off you will be.

But there is also a catch. In real estate investing our natural psychology can sometimes pull us away from doing the right thing. The unique challenge of successful investing is that many real estate investors do not quite really understand how investment probabilities work, so they are not able to put them to use. Furthermore, many investors are unaware of how their own psychology leads them away from basic investment principles. Successful real estate investing is in direct function of putting the Axioms of Investment Probability in one's favour. These Axioms are:

[ ] In the long-term, real estate markets are predictable and invariably tend to move upwards.

[ ] Risk is largely absorbed by holding many fractional smaller investments instead of a large single investment.

Let's now examine these Axioms closely, beginning with the first. Why are real estate markets unpredictable in the short-run?

In real estate, of course, no value is more important than market value - and no other factor is of a more ephemeral nature. This is so because real estate is an imperfect market. Although commonly and somewhat misleadingly referred to or otherwise thought of as one market, real estate consists of several, smaller markets, each one of which is constantly subjected to and shaped in accordance to external influences and in direct function of economic variables. Externalities the likes of demographic variations, income fluctuations, trends and social preferences, technological progress and government policies - all have a bearing on the desirability of a certain real product and all are proximate factors affecting demand and, conversely, supply at any given time. As such, the numerical determination of market value is also shifting in the short run to follow and reflect the impact of externalities.

This leads us to the second Axiom, that is in the long run real estate markets are more predictable in that many of the above-mentioned externalities have settled already into and have become part of what we, in real estate, refer to as ‘established markets'. Sure, it is tempting to invest into newly-developed neighbourhoods, or even into sprawling new towns, but fact of the matter is that real capital assets hold their values better in established neighbourhoods in the long run. New subdivisions and developments are invariably more exposed to the conditions of the moment, whether the developer is lowering prices because he is pressured by his own financial commitments, or merely because the market turns ‘soft'. In hindsight what may look as a ‘good deal' today may not be a good deal at all tomorrow.

By contrast, values in established neighbourhoods tend to be more stable, since housing supply is produced using land, labour, and various inputs such as electricity and building materials. And, clearly, in older neighbourhoods the value of land typically skyrockets, since supply of land is exhausted. As real estate is a fixed and durable commodity and the land underneath is practically indestructible, in Economics real estate markets are modeled as a stock-over-flow market. About 98 percent of supply consists of the stock of existing houses, while about 2 percent consists of the flow of new development.

And why is it the prices of real capital assets invariably tend to increase in the long-term? The production of real estate output requires a constant supply of a labour force which can conserve and add value to inputs and capital assets, and thus create a higher value. The rationale behind this is that labour adds value by satisfying demand through production, since when people acquire income they tend to invest it, and the more people that acquire income the more people that tend to invest it. Therefore, there is a correlation between capital and employment in real estate or, if you will, between income and labour. An increase in levels of consumption sets forth an increase in prices caused by a corresponding increase in demand, in itself generated by a commensurate increase in the income-employment factor. It follows, therefore, that growth is derived by the equilibrium of capital and investment with labour and employment. This is specifically the reason why many economic analysts keep their eyes on interest rates and levels of employment, when it comes to forecasting and anticipating the future performance of real estate markets.

As to the third Axiom of Investment Probability, it is a recognized concept in modern economic investment theory that the risk of investing in several real capital assets is not equal to the sum of the risk of each asset but that, rather, it is lower than the sum of all risks. The reason is that the risk of each real capital investment is offset, to a certain extent, by the risk of other real capital investments. The lure of a single high-yield investment is tempting and capturing but, all other variables being constant, many fractional smaller investments add up to the same yield over the same capital investment with a much lower degree of risk.

Wednesday, December 13, 2006

How Did Our Oil Get Under Their Sands?

Recounting sixty years of Western economic policies that have led to the rise of Islamic Fundamentalism in Iran.

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At a time when yet another conflict has just finished emblazing the Middle East which involved the Jewish State of Israel on one side and Hezbollah, the paramilitary militia founded, trained and financed by the Islamic Republic of Iran on the other side, and also at a time where a civil war in Lebanon seems to be in the making once again directly involving Hezbollah and Syria and Iran indirectly, it is worth to take a look at the initiatives, economic and military, launched and underwritten by the West in Iran throughout the years. The importance of looking back at history is to be found in the fact that, far from being a tug of war between the Israelis and Hezbollah, this relatively localized conflict threatens to expand well beyond the borders of Lebanon, and to involve players much bigger than the ones who are presently fighting. Particularly when one can find calls already on the part of some decidedly extremist Bloggers and columnists, that the time has come to drop a couple of bunker-buster bombs on Iran's uranium-purifying facilities. It is also all the more important to know the plight of the people and be aware of the circumstances that have given rise to the ascent of Islamic Fundamentalism in Iran, a country which is placing itself - now more than ever - in a collision course with the West.

It is difficult for Westerners to fully grasp the sheer force of nationalistic feelings in Iran, and how much these feelings centre on oil. With virtually no other natural resources and a history of being under foreign domination, the people of Iran have come to see oil as their economic lifeline, upon which the foundations of any vision of national identity and pride must necessarily be built. And, ironically, these very nationalistic feelings have inevitably brought them in the past to clash with the powerful economic concerns of the West, who saw the region's oil as their own legitimately-claimed property.

By the early 1950's international oil companies had managed to effectively gain control over Iranian oil, and a desire to take that control back became a potent force throughout the country. It was a drama that was played out most vividly - and tragically - in 1951, when the charismatic Mohammed Mossadegh became a towering nationalist figure. With his inspiring visions and powerful oratorical skills, Mossadegh attracted a huge number of followers. Because of this a parallelism has been drawn by many historians between Mohammed Mossadegh and Martin Luther King, Jr. in terms of political and social effectiveness on the masses. Mossadegh was a democrat with a deep commitment to the rule of law. He was also at the head of a movement that pioneered democracy in Iran with great success.

One of the most volatile issues in Iranian politics was the enormously favourable deal that had been granted to a British oil concern, the Anglo-Iranian Oil Company. This name was, in fact, a misnomer since there was nothing remotely Iranian about it. It was entirely British owned, and it had been given a sixty-year concession for all of Iran's oil. As a result, massive revenues from Iranian oil flowed into the British treasury, while Iran merely received a small token share of the revenues and had no voice whatsoever in the company's management - not even the right to audit the company's books.

It was within this context that the then Shah of Iran - Mohammed Reza Pahlavi - backed politically and financially by the British, in 1949 tempered with the national elections in order to secure a legislative body favourable to Britain and to the status quo. Mossadegh instead favoured the revocation of all oil rights and called upon all those who wanted fair elections - which numbered in the tens of thousand - to hold a vigil in front of the Royal Palace in Tehran. After a vigil of three days and three nights, and so as to avoid the start of what was promising to be a civil war, the Shah agreed and granted new elections.

Mossadegh was elected triumphantly, and immediately began the political push for more democracy and for more national control over oil. By the end of 1951, with enormous popular support, Mossadegh recommended that the Anglo-Iranian Oil Company be entirely nationalized. This move passed fully in the Iranian legislative body and in the Senate, even though both were controlled by the Shah's appointed deputies. The British were flabbergasted as the Iranians, under the leadership of Mossadegh, proceeded swiftly with the nationalization of the Anglo-Iranian Oil Company and all of its assets.

Britain viewed the takeover by Iran as nothing short of a coup d'etat. In fact, even more than that, as a slap in the face and an affront to Britain's honour. Declared Sir Anthony Eden, the British Foreign Secretary:" Our authority throughout the Middle East has been violently shaken by the insolent defiance of decency, legality and reason of a group of wild men in Iran". A sentiment, this, echoed by Dan Acheson - the then US Secretary of State.

The international oil companies quickly swung into action, collectively coming to the defence of one of their own. An attack on Anglo-Iranian Oil was seen as the precursor to an attack on the international oil establishment and on the sanctity of oil companies to the region's oil reserves - especially by the Americans. The major international oil companies, therefore, spearheaded by Exxon cooperated in imposing a worldwide boycott on nationalized Iranian oil. The British and US governments backed the embargo, and Washington pressured the American oil industry to respect the boycott and to refuse to enter into any contract for the exploration and development of Iranian oil resources. The boycott succeeded in cutting off Iranian oil from world markets, devastating that country's economy. So effective was the embargo, that Iranian oil exports dropped from USD 400 million in 1950 to less than USD 2 million in 1952!

Even so, the boycott failed to bring Mossadegh's government down to its knees. In fact, if for nothing else, it served to increase Mossadegh's popularity among the Iranians as well as throughout the Middle East, in that he quickly became a symbol of defiance of British power and Western capitalism. In the face of such popularity Prime Minister Winston Churchill, a strong supporter of British imperial power, became convinced that Mossadegh had to be stopped at all costs, and requested Washington's help to this effect. He found the perfect timing in the transition from the Democratic Administration of Harry Truman to that of Republican Dwight Eisenhower, who was inclined to see Iran as a potential battleground between the United States and the Soviet Union. Eisenhower gave the green light to the CIA, which then dispatched Kermit Roosevelt - the grandson of President Theodore Roosevelt - to Tehran. Roosevelt spent a week meeting secretly with the Shah to win his support for the coup d'etat. Reza Phalavi was initially against a coup for fears that it would fail, but in light of the many concessions made by Roosevelt - including US military support for his regime - the Shah finally agreed.

The coup succeeded. The enormously popular Mossadegh was arrested, tried by a military tribunal, found guilty of treason and incarcerated in a military prison for three years. Upon his release, the Shah ordered Mossadegh to be placed under house arrest until his death, which occurred in 1967.

The US-led coup d'etat became a defining moment in the history of Iran, if not of the entire Middle East. To some extent it served as a lesson and a reminder to those who longed for greater national control over their countries' oil industries. But at the same time, by exposing what many thought of as the imperialistic aims of Western powers, the coup in Iran became a rallying point for anti-Western nationalism in the region for years to come. At the forefront of this anti-Western sentiment were two men - an Egyptian and an Iranian - whose names were to become very well known in the West: Gamal Abdel Nasser (1918 - 1970) and Ruhollah Musavi Khomeini (1900 - 1989).

Nasser's appeal lay in his willingness to defy Western powers, most notably the US, and in his fierce advocacy of Arab sovereignty and unity. In 1956 Nasser claimed Egyptian control of the Suez Canal, the vital conduit for moving oil from Iran to Europe and proceeded to its nationalization, thus precipitating the Suez Canal Crisis. In early October, the United Nations Security Council met on the matter of the Suez Canal and adopted a resolution recognizing Egypt's right to control the canal as long as it continued to allow passage of foreign ships. On October 29, 1956, however, Israeli forces moved into the Sinai Peninsula and on October 31, 1956 a joint force from Britain and France entered the Canal Zone. On November 5, 1956, the Soviet Union issued an ultimatum demanding the withdrawal of all foreign forces from Egypt, and in this the Soviets found an unlikely ally in Washington. Britain, France, and Israel reluctantly complied and gradually removed their forces, thus ending the Suez Canal Crisis.

Less visible but even more effective in shaping the Middle East was the life of Ruhollah Khomeini. After graduating from the Islamic seminary of the holy city of Qom, the future Ayatollah taught the Shariah, the Islamic Law, for many years and wrote numerous books on philosophy and mysticism. In 1963, he publicly denounced the government of Shah Mohammad Reza Pahlavi and was thereby imprisoned for 8 months. Khomeini, already a recognized figure in Iranian politics, had originally been sentenced to death, but the Shah felt that his execution would anger the common people of Iran. Upon his release from prison, the Shah ordered him to leave the country.

Khomeini initially went to Turkey but was later allowed to move to Iraq, where he stayed until he was forced to leave in 1978 by the then Vice-President Saddam Hussein. Khomeini moved to France, where he became one of the most influential opponents to the rule of the Shah, and where he further became to be perceived as the spiritual leader of all those fighting Reza Pahlavi. During his exile, Khomeini wrote a book entitled Guardianship of the Islamic Jurists, where he laid out his three fundamental beliefs: 1) that all laws in an Islamic society should be based on the laws of God (Shariah); 2) that all laws and activities of the state should be monitored by clerical authorities on Islamic Law (the Mullahs, or guardians); and 3) that Islamic countries should become republics and not monarchies. Khomeini believed that the leader of an Islamic Republic should be a faqih (an Islamic jurist, who is also a member of the clergy), who should be selected by a group of clerics. The Supreme Leader, as the post is officially called, would have absolute secular and religious authority, and could only be removed from power by that very same group of clerics.

The book, furthermore, provides an insight on the eventual political background of the Islamic Republic of Iran. In short, after the success of the revolution, Khomeini replaced the monarchist government of the Shah with a theocratic system dominated by the clergy, with the approval of 98 percent of the voters sixteen years of age and older, who were called in a referendum to determine the question of accepting an Islamic Republic as the new form of government and constitution.

The history of Iran is tied to and intertwines with Western economic policies in the Middle East, especially those of the United States. Nearly three decades have passed since the leaders of Iran and those of the US have communicated openly, and with the war in Lebanon going on the prospects of talks between the two countries seem more remote than ever. This is so because opening talks with Iran at this time would confer legitimacy on Iranian leaders who, aside from their suspected desire to obtain nuclear weapons, deny Israel's right to exist and support Hezbollah, a terrorist organization.

Additionally, many experts believe that no matter what incentives the US or the world offer, Iran is determined to become a nuclear power. This fact alone raises the specter that the US - or even Israel if aided by the US - might take military action to destroy Iran's nuclear facilities. As much as this scenario causes shudders among European and Arab states allied with America, it is indeed not that incredible or farfetched, and the odds of a military intervention in Iran increase exponentially with every passing day that the conflict in Lebanon continues, and with each and every inflammatory statement and the rhetoric of confrontation that President Mahmoud Ahmadinejad seems to be so fond of dispensing.

The Hezbollah flags that we are increasingly beginning to see in demonstrations organized by Muslim communities in London, Paris and Rome, furthermore, are yet another reminder - especially to European nations - that the confrontation in the Middle East may not be limited to the arid plains of Lebanon.

Friday, December 08, 2006

China's Incredible Real Property Appreciation

Readers who routinely follow my articles on Real Estate Economics are fully aware of my position on real estate bubbles in North America.

A real estate bubble occurs when prices of real capital assets become so absurdly high that consumers either refuse or cannot afford to purchase, thus sending demand tumbling down. This has not happened in North America's real estate markets, where we have assisted at either a slowdown in property appreciation or a depreciation of values in line with the Fed's forecast of late 2005 and the beginning of the year, as well as with those of many economic analysts - including myself. This is the reason why this time around I wanted to give an example of a true real estate bubble.

As reported by the official Xinhua News Agency, there is a growing concern among top officials of the People's Republic of China that surging prices in major cities threaten to create economic overheating and serious social unrest. This has prompted a new crackdown by the Chinese leadership on property speculation. The National Development and Reform Commission (NDRC), the state planning agency, in fact reports that in North-eastern Dalian in the first three months of this year prices for new properties jumped 15 percent from a year earlier, and that prices in the Southern boomtown of Shenzhen gained 10 percent in the same period. While in Beijing, says the NDRC, prices were up 17 percent amid euphoria over the forthcoming 2008 Olympics in the Chinese capital.

But before you hop on to the first flight for Beijing, read this. Chinese economists say that owning an apartment is now an unrealistic dream for large numbers of urban residents who are falling further behind as home prices surge. The core of the problem appears to be the disparity between prices of real capital assets and wages. More specifically, the average apartment in the city costs 13 times the annual average salary.

Now, that's what I call a real estate bubble!

The main reason for this huge levitation of prices is speculation. Speculation is one of the many forces that act on capital at any given time. In theoretical Economics, speculation is defined as ‘the acquisition of financial or capital assets made solely to quickly profit from fluctuations in their prices, or of goods or commodities with no real intent to consume or otherwise use them for production'. Basically what many Chinese speculators are doing is flipping apartments, even before they are built. NDRC reports that many developers have gone even as far as creating independent companies that they themselves control, the sole purpose of which is to buy the apartments the developers are in the process of building and then resell them with a markup, thus inflating prices.

Property is a big driver of Chinese economic growth, and runaway investment in the real estate sector has contributed to signs of a broader overheating. The economy grew by a red-hot 10.2 percent (annualized) in the first quarter of the year from a year earlier, when it grew to the tune of 8 percent per year. Concern about too-rapid growth has prompted the government to raise bank lending rates by 0.27 percentage points last month to discourage borrowing and reduce investment. Officials fear that overheating could lead to a sudden economic crash. Additional measures are in the wings, including hefty increases in property taxes, again to take aim at property developers who hoard land and buildings, a practice that creates artificial shortages and drives up prices.

Scarier still is the social unrest that the leadership fears if the economy does not slow down to more manageable levels. This is due to a growing imbalance of wealth rampant in China's population of 1.3 billion people, wherein thirty-five percent of the population lives in the cities and sixty-five percent inhabits the countryside. There is a system of residence controls, so that if one is lucky enough to be born in a city - and registered as a city dweller - it is easier to get into university or to work at all the large companies and government agencies in the city. If, conversely, one is registered as a rural person there are very severe restrictions on where he can live and work. And this is actually the biggest human rights problem in China today. The majority of this population of 1.3 billion people consists, by law, of second-class citizens who live for the most part in conditions of abject poverty, in rural huts many of which do not even have running water. One can imagine how these people feel when they look at the way their urban counterparts live.

The economic ripples and effects that a speculation in grand style such as this have on market wealth are indeed humongous. Market wealth is defined as ‘the combination of materials, labour, land, services and technology in such a way as to capture a profit' (Adam Smith). The aftershocks of a bubble of this size that bursts are usually terminal and irreversible: market wealth disappears, it vanishes entirely. And it takes forever to re-build it, right from scratch. Here in the West, the greatest example in recent times is the infamous Black Monday - October 19, 1987 - when the Dow Jones collapsed 22.6 percent in value in a single day! It took nine years for Wall Street to lure investors back.

But then, how much is too much? Well, consider this: at the top end of the market, even the smallest apartment in a building next to Citigroup's skyscraper on Shanghai's waterfront is stunningly expensive. Complete with all-copper doors and Swarovski crystal lights it costs about USD 2 million or USD 1,670 per square foot - and no fireplace.

Monday, December 04, 2006

Outlook 2007: Reverberations Of The Real Estate Slowdown

Looking at the bright side of things, now that I am unemployed ...

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About a year ago I wrote an article entitled "Breaking The Real Estate Bubble Myth", which won great acclamation among readers - at least judging by the many positive e-mails the article generated. It also catapulted me, so to speak, in the spotlight of the local news when a television station requested an interview, which I happily granted.

In the article I pointed out, among other things, that for 2006 real estate markets were expected to settle to new, more commensurate pricing levels and that, furthermore, a cooling-off trend through higher interest rates would have the beneficial effect of consolidating market wealth achieved thus far. The real estate bubble would be likely to burst if no pressure were applied on speculation, thus increasing prices even further and causing demand to lower and finally collapse.

Instead, allowing the economy to get an even footing through a slowdown of capital appreciation and at the same time allowing real wages to catch up, I reasoned, would be exactly the tonic needed for a healthy foundation. Higher interest rates, moreover, promote domestic saving and attract foreign capitals thus reinforcing both the Greenback and the Loonie, another beneficial factor in finance albeit not in trade.

Approximately twelve months down the road this forecast seems to have come true, for the most part.

In general lines spending fuels consumption, which in turn erodes a limited quantity of resources. This is the concept behind inflation in an economy founded on scarcity of goods, which is typical of all capitalistic economies. There is nothing that increases spending more than speculation, defined as the purchase of capital goods, which are instantaneously consumed - i.e. sold for profit, and in North America we all have done a great deal of speculation in the past few years, especially in Real Estate.

At the end of 2006, there is no longer any doubt that the housing slowdown is well under way, both in terms of new construction as well as falling housing prices. In the United States in particular, new numbers released by the National Association of Realtors (NAR) indicate that the median price for existing homes fell by 1.7 percent in the year to September, and that the median price of new construction suffered a drop of 1.3 percent for the same period. And since inventories of unsold homes in many areas are unusually high, NAR forecasts that prices are bound to drop even further, at least through the first quarter of 2007.

In Canada the situation is somewhat better, as reported by the Canadian Real Estate Association (CREA), in that inventories of unsold homes are not as high as in the United States. Still, CREA reports a drop of median prices for single-family detached hovering to about 1 percent as of September, and anticipates a downward pricing trend through the first quarter of 2007 as well.

Today's debate, however, is less about the scale of the housing slump than its consequences. Will North America be dragged down into a recession or will the economy somehow shake out the property bust? Most Wall Street economists as well as most analysts of major banks in both the United States and Canada put the odds against a recession. And Fed Chairman Ben Bernanke sounds somewhat optimistic as well, although with a great dose of reservations.

The economy is definitely slowing, particularly in the United States, but this is not entirely due to Real Estate. There are political factors as well, the likes of the continued instability in Iraq and an increasing unrest in the Middle East in general, and the shift in power in Congress that play a pivotal role in economic affairs. GDP is now expected to increase at an annualized trend of 2 percent, which is well below trend, in the fourth quarter, and the most direct and least debated effect is the drag on overall output, as builders cut back substantially.

Add in the effects of unemployment: as housing stumbles, economists reckon the industry will shed jobs, pulling down the overall job growth to less that 100,000 per month throughout 2007, thus pushing up the unemployment rate. Whether, therefore, all this will translate into a recession is a matter of debate, and will depend entirely on how consumers will react.

Whereas it is in fact true that consumers, especially Americans, are going to feel less wealthy and will not be able to use their homes as gigantic cash-machines by financing their spending habits through the use of their equity, it is indeed a matter of fact that the link between mortgage-equity withdrawal and consumption is no longer as important as anticipated. The pace of equity withdrawal has already slowed without particularly dire consequences, falling from a high of 7.9 percent of disposable personal income in the third quarter of 2005 to 3.3 percent in the third quarter of 2006 (Source: US Department Of Commerce).

Because the mortgage-equity link is weaker than expected, arguably falling house prices will have a milder effect on consumer spending, thus reinvigorating consumers confidence. For the final result to be tallied, we will have to wait for the US Department Of Labour to publish its 2006 tables in early 2007.

More important for the overall state of the economy, furthermore, is the fact that the chilling effects of weak house prices are being countered already by other boosts to consumers, particularly from lower fuel prices and stronger than anticipated income growth. The Department Of Labour reports that wages and salaries have grown at an annualized rate of 7 percent to September, and that oil prices have fallen an average of 45 cents per gallon in October. Both indications these, that would suggest that consumer confidence is on the rise and should continue to remain high in the forthcoming months. And if that turns out indeed to be the case, the economic reverberations of the slowdown in Real Estate will be definitely toned down.